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Building Year-Round Profit

Extreme seasonality has always been a challenge for tax practitioners. With over 90% of annual tax preparation revenue being realized in about 80 days, tax firms are in the same situation as many seasonal vacation resorts, and far worse off than most retailers. Problems posed by extreme seasonality include:

severe cash shortages during eight months of the year

difficulty finding and keeping qualified people

inability to afford prime office space which is utilized fully for three months of the year

high cost of renting or buying equipment and furnishings for only 3 months

uncertainty of revenue results from season to season, due to such problems

Planning for and operating a tax business is very difficult and, with few hard assets, conventional sources of financing are hard to come by.

As if these challenges aren’t enough, now tax practitioners are faced with the threat of obsolescence due to legislation and technology. The greatest challenges are radical changes resulting from technology such as sophisticated tax preparation software packages now available to taxpayers for less than $25, and new IRS options enabling taxpayers to file electronically without using a tax practitioner (e.g.: telefiling, E-filing by mail using Form 1040PC, and by PC through a service bureau). These new taxpayer options are just the beginning of a new era of self-preparation and E-filing that will be made possible for most taxpayers through new technology applications. The tax industry will also change dramatically as it adopts new technology applications such as wide area networks, computer information systems, and communication systems such as the Internet. Such changes will redefine the way tax practitioners provide service to their clients, as well as the services they provide.

These dramatic changes are taking place in a highly competitive, low-growth, mature industry. How will those of us who depend on the tax preparation business for our livelihood survive? These difficult problems will require creative solutions. The good news is that you can get help from trade associations such as the National Association of Tax Practitioners and tax industry software and other support venders, and you will have ample time for planning to reposition your business for the 21st Century.

Seeking Answers:
Diversification is a logical solution for many tax practitioners. By adding services and products with year-round or, ideally, complimentary seasonal revenue, we can flatten out the seasonality and reduce our dependency on the tax business. Most of the remainder of this article will be devoted to diversification. But first, let’s not lose sight of our core business and opportunities that invariably arise with change.

Change, although often unsettling, can be very positive. Historically, any change in the tax code, even true tax simplification, has caused confusion among taxpayers and resulted in more people seeking professional tax help. The 1986 Tax Reform Act, by eliminating scores of deductions, has converted many taxpayers from long-forms to short-forms resulting more self-preparation and reduced fees for many clients. Additionally, the absence of significant tax code changes in recent years has enabled more taxpayers to become self-preparers by copying what was done in the past. Increased standard deductions, exemption allowances, and filing requirement thresholds have also eliminated many low-income people from the tax rolls. The negative impact on the tax industry of these changes was partially offset by expansion of the Earned Income Credit and fast refunds through the IRS electronic filing program. However, many tax practitioners who failed to capitalize on these opportunities suffered losses. On the other hand, some practitioners who became overly dependent on fast refund revenue have gone out of business due to the elimination of the IRS direct deposit indicator and IRS auditing of earned income credit claims during the 1995 tax season.

These experiences should remind us of some old lessons: (1) change is inevitable; we must anticipate change and be prepared for it, (2) changes always bring new opportunities for those who are willing and prepared to capitalize on them, (3) it isn’t wise to put all of your eggs into one basket. To survive and prosper you must: (1) have a plan, (2) be progressive, and (3) be resourceful.

DEVELOPING A PLAN

Establish Goals:
The first step toward long-term success and prosperity is to set long-range goals. As the saying goes, “if you don’t know where you’re going, any road will get you there”. Your firm’s goals should reflect your vision as the entrepreneur, but should be developed with input from your key employees. The people upon whom you depend to help you succeed must believe that the goals are suitable and attainable. Actively involving your key people in shaping the goals will result in a better set of long-term goals and help insure their buy-in. The involvement of an objective outside advisor may facilitate the process of planning.

Goals must be stated clearly and must be in measurable terms. This will ensure that the degree of achievement can be measured exactly and will be determined by objective criteria.

The following are among the 3-5 year goals recently adopted for Peoples Income Tax, Inc. by the CEO and vice presidents with input from several other key associates and advisors:

Goal 4 – Diversify into additional complimentary businesses to reduce dependency on the tax business and generate profits in every quarter.

Take Inventory:
As part of the strategic business planning process, key strengths and assets will be identified. These resources must be utilized as fully as possible to achieve the desired goals. Planning to diversify is one element of a strategic business plan. Please refer to the discussion on SWOT Analysis (Strengths, Weaknesses, Opportunities and Threats) in the article by this author on strategic business planning in the Summer 1996 issue of The NATP Tax Practitioners Journal. Don’t overlook your existing clients as key strength upon which to build. To achieve some of your goals, such as diversification, you will probably need to acquire new expertise, and you will probably have to develop new delivery systems and capacity.

Identify Opportunities:
There are always more opportunities than you can possibly pursue. All possible opportunities should first be identified. “Brainstorming” is a time-honored method of identifying such opportunities. To brainstorm effectively, your key people and/or advisors should be assembled in a comfortable room away from all distractions to focus on one specific goal at a time. A facilitator would be needed to elicit ideas and record them on a flip chart. Participants should be asked to think about the goal or problem and come up with ideas. No one is allowed to question, criticize, discuss or debate any idea that is mentioned. Every idea is recorded on a flip chart sheet and, when full, each sheet is taped to the wall. After the session (30-45 minutes), all ideas can be discussed by the group, consolidated to eliminate redundancy, and distilled down to those that are potentially viable. This process can be repeated for each goal.

Prioritize Opportunities:
After all viable opportunities are identified, they should be classified into short-term and long-term possibilities. Short-term opportunities are those that the company has the resources and capacity to undertake immediately (or the ability to easily add the necessary resources and capacity). Long-term opportunities are activities that the company definitely should pursue; but may not be able to do so at the present time without impairing its short-term health and prosperity. Making these distinctions is often difficult. Some long-term opportunities may involve moderate short- term risks, but promise substantial rewards if successful. And some high-risk pursuits may involve a short “window of opportunity”, after which time it will be too late to capitalize on an opportunity. Other long-term opportunities may not diminish with the passing of time. Keep in mind that the significance of a reward is usually relative to the degree of risk. Thoughtful consideration using good judgement based on experience and tempered with an objective outside perspective will increase the probability of success. Once consensus is reached, short and long- term opportunities should be grouped and each set ranked in the order of greatest potential to contribute toward the company’s goals. Some long-term opportunities can be put on the “back burner”, others should be kept constantly in mind while pursuing short-term goals, and a few should be actively pursued along with short-term objectives.

Develop Strategies and Tactics:
Achievement of each goal will call for making choices and developing strategies and tactics. Each viable opportunity usually translates into a strategy, or a broad means of attaining or helping to achieve a goal.

A tactic is a specific method of implementing a strategy. Several strategies, each with multiple tactics, will usually be necessary to achieve a goal. These strategies and tactics must be prioritized and then implementation plans need to be developed for each one.

Determine Needed Resources and Sources:
Your first goal in diversifying could be to fully utilize your existing resources. Resources such as your people, computers, office space, etc., which are idle during the off-season, represent opportunities to expand while incurring little or no additional fixed costs. Using existing resources during the off-season can produce benefits in addition to revenue, such as the retention of key people through year-round employment and year-round public visibility. Caution should be exercised, however, not to divert critical resources from your core business. For example, if you redirect the efforts of a key tax preparer to do small business accounting, you could have a serious staffing problem when tax season comes around again unless you find a replacement.

Many new activities obviously will require additional resources. The source(s) and cost of these resources must be determined in order to develop a plan. (The resources must then be acquired in order to implement the plan.) Overlooking or underestimating necessary resources is a common error. For example, any new activity will require management. If existing managers are to oversee the new venture, will they be overextended resulting in neglect of the core business? Ideally, each business will have separate management and workers unless the business compliments the seasonality and skill requirements of the tax business (e.g., The Income Tax School). Other resources include equipment, facilities, furniture and fixtures; and marketing, management and operating systems. The new venture cannot be started until all necessary resources are in place or lined up.

Conduct Research:
You need to do your homework before jumping into any new venture, especially if you will be going into a business in which you lack personal experience. Talking to people who are already in the business is a logical first step, and you can usually find them in the Yellow Pages. Of course, you’ll need to find people with whom you will not be competing, at least not directly. If there is no one you can talk to locally, you could find someone in another city or town that is near enough to visit.

Another source of information is trade associations; lists of national trade groups for every industry can be found in most libraries. Local trade associations or business support groups may also provide resources and have meetings you could attend. The U.S. Government Printing Office publishes booklets on how to operate numerous businesses and how to address many different business issues. The U.S. Chamber of Commerce and your local chamber can provide business support and information on various industries and market conditions. Other sources include your state and local departments of economic development and local universities.

You will need to determine any licensing requirements, and the licensing agency may provide helpful information on how to get started. You’ll also need to assess the competition and the market to determine how much revenue you can realistically expect to generate.

Develop Your Business Plan:
A full-blown business plan may not be needed to add related and complimentary services such as small business accounting, income tax school and tax planning. However, you will need to establish an operating system, assign or hire personnel and management, and develop a marketing plan. If you are entering a new business such as real estate or insurance, you should develop a comprehensive business plan. The outline provided as Appendix B can be used as the framework of your plan. For detailed information, see the article on Strategic Business Planning in the Summer 1996 issue of The NATP Tax Practitioners Journal.

DIVERSIFICATION ALTERNATIVES

Joint Ventures:
Don’t abandon a good idea because you can’t personally acquire the necessary resources. Resources needed for a new venture can be acquired, or the cost shared, through a joint venture. Although profits may have to be shared, the advantages of lower start-up costs, new expertise and faster entry to the market can far outweigh that factor. A joint venture could be a true partnership or simply a sharing of resources, such as office space, office equipment and a receptionist. Look for partners whose expertise compliments yours, who have resources you need, or who have clients who fit the profile of your prospects. Think about a potential joint venture from their point of view–what’s in it for them? Unless a joint venture is truly a win-win arrangement, it won’t succeed.

Joint Marketing:
A joint marketing arrangement is also an excellent way to achieve the leverage necessary to enter a new market. For example, if you want to attract small business accounting clients, you could conduct joint seminars with a law firm and a brokerage firm to prospect for clients. By teaming up with non-competing professionals seeking the same clientele, your marketing cost could be cut by two-thirds or more. In fact, a brokerage firm might be willing to include you in an existing seminar at no cost to you in order to offer a broader appeal. Opportunities may also exist in cross-marketing to one-another’s client bases. Other approaches include operating a lease- department within a complimentary office or retail store, a joint mailing, or a special offer insert with a mailing to clients of another firm.

Franchises:
Although a franchise may appear to be expensive at first glance, this route can be far less costly than trying to build a new business from the ground up. Unless the geographic restriction is of concern to you, a franchise is worth considering for certain businesses such as a real estate or temporary help agency. Your investment in a first class franchise can provide the following advantages over developing your own business systems: (1) your risk of failure should be greatly reduced by using a proven system, (2) your initial cost (franchise fee) for operating and marketing systems should be much lower, (3) conventional financing should be more accessible, (4) the “ramp-up” time for the business to become profitable should be much shorter, (5) you will receive professional training and support, (6) you should enjoy lower supply costs due to economies of scale, (7) the marketability and resale value of the business should be greater, and (8) advertising costs may be reduced through co-op campaigns with other franchisees or the franchisor. Your long-term profits may be lower due to ongoing franchise royalty payments. However, a good franchisor will continue to provide its franchisees with value for their money. Also, the value of name recognition of a regional or national franchise can more than offset a lower profit margin.

Once you identify a franchise in which you are interested, you can request their literature and Uniform Franchise Disclosure Document which contains a detailed description of the franchisor including historical and financial information and names of franchisees. You would be wise to contact two or three of their franchisees and, if possible, meet with at least one at the business site. Obtaining legal assistance in negotiating the franchise agreement is usually advisable.

Licenses:
Another alternative to developing your own operating and marketing system is to obtain a license to use a proven business system. A license may be exclusive or non-exclusive and usually differs from a franchise in two key ways: (1) you are buying the right to use a system only and not a name or trademark (you would trade under your own name), and (2) for a license you usually pay only an annual license fee instead of an up-front franchise fee and ongoing royalties (a percentage of all revenue generated). As with a franchise, operating supplies and marketing materials may be sold separately. Peoples Income Tax, Inc. offers licenses for The Income Tax School system and several tax practice management systems. For information, call 1-800-984-1040.

Agent or Representative:
If your interest is only in generating income and not in building equity, many opportunities exist to become an agent or representative of a successful company. For example, to sell financial products, instead of becoming a broker-dealer (a complex and costly process), you can become a representative of a broker-dealer. (You would need to obtain the securities licenses required to sell various types of financial products.) Or you could obtain the required license and become an agent of an insurance or real estate broker. Many other income opportunities exist such as distribution agreements for products such as Amway, Mary Kay, Tupperware, and scores of others. Finding work that your seasonal employees can do during the off- season (possibly using your idle office space and computers for a fee) could be a win-win for you and them. You and they can each generate income, and you might keep some key people from taking full-time jobs elsewhere.

Utilizing Offices & Equipment Year-Round:
Sub-renting idle office space during the off-season will generate profit. Some of the many possible short-term sub-rental uses are: (1) political campaign headquarters (get full rent and a security deposit up front), (2) telemarketing campaign, (3) employment agency satellite interviewing site, (4) seasonal boutique, (5) holiday packaging & shipping center, and (6) adult education classroom, and (7) remedial tutoring or SAT preparation center. Computers could be rented out by the week or month during the off-season, or used by you to conduct training classes in various business office software applications.

Buying A Business:
Starting a new business from scratch is a costly and risky undertaking. An alternative to buying a franchise is buying an established business. However, healthy established businesses are scarce and there are lots of other people looking (such as executives displaced by corporate downsizing). There are also many potential pitfalls in buying a business, such as the following: (1) historical financial statements may show a false picture for various reasons, such as overstated revenue or inflated assets, (2) customer goodwill may not be easily transferred to a new owner, or clients could be solicited by the former owner or employees after the sale, (3) a building, if included in the sale, could be a “white elephant”, (4) the office lease could be expiring or may not be assignable, (5) equipment, furnishings and fixtures could be obsolete or worn out, (6) critical employees (including the owner) may not be willing to stay on, at least during the transition period, (7) trade names may not be registered, (8) inventory could be over-valued or non-existent, (9) hidden liabilities may exist (You may want to buy only the assets, not the legal business entity.), and (10) the industry or market may be facing threats from increased competition, technology, legislation, etc. that will negatively impact future revenues or costs. Because of such risks, great care must be taken in evaluating a business. Unless you have the time and skills to scrutinize the business, you should probably hire a professional consultant to do so. Using a reputable business broker may also be a good idea to help find a suitable business and negotiate with the seller. And you should be represented by a competent attorney to draft the agreements.

Buying a practice or a client list is a common approach in professional service industries. This approach is much cleaner and less risky than buying the entire business. However, assets that are critical to the business which you do not already own should also be acquired. A non-compete provision with the seller (and/or employees) that can be enforced may be a necessity. Ideally, the sales price will be determined or adjusted based on the actual revenue realized from the clients in the first year.

Financing the purchase of a business or practice should generally be on an installment basis. This method is usually to the advantage of both the buyer and seller for tax purposes. And an installment payment plan can provide for adjustments in the purchase price in the event certain representations by the seller are not realized. An installment purchase with the note held by the seller would also eliminate the difficulty and added cost of securing bank financing.

Cross-Selling to Clients:
The cost of acquiring a new client, on average, is substantial. To the extent this cost can be reduced, your business will be more profitable and successful. Diversification affords the opportunity to acquire new clients and to improve your retention rate of existing clients. By diversifying into businesses that serve the same types of people that you presently serve, you can cross-sell the services or products of both businesses to all clients. Because the relationship has already been established, cross-selling is much easier and less costly than finding new clients. To add icing to the cake, marketing studies have proven that providing two or more services or products to the same client helps to bond that client to your company. Therefore, cross-selling should also improve your client retention rate.

Diversification, if well conceived, properly planned and correctly implemented, can greatly strengthen your business and insure your success and prosperity well into the 21st Century!

About the Author:

Charles E. McCabe

Chuck, a 40-year veteran tax industry executive, has managed hundreds of tax preparation offices in the U.S. and Brazil. He earned his B.S. degree in management (summa cum laude) from Adelphi University and Executive M.B.A. degree from Pace University, where he also completed doctoral studies in business. He is founder and President of Peoples Income Tax, Inc., which operates 18 tax preparation offices in central-Virginia and licenses income tax school and tax practice management systems to independent tax firms nationwide.

Chuck is involved in numerous community and small business advocacy activities. He is co-author of two books on career education for adults and numerous articles on adult education, income tax and management. He has taught small business management as an adjunct faculty member of Virginia Commonwealth University.

Note to users:

All information provided is general in nature and intended only to create awareness, not to address the specific circumstances or concerns of any individual or enity. Although we try to provide correct and timely information, we cannot guarantee the accuracy of any information or that such information will continue to be accurate in the future due to the changing nature of the tax laws. Before acting on any of the information provided here, you should consult with a professional advisor who knows all of the unique facts and circumstances pertinent to your particular situation.

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